Can Industry Consolidation Lead to Greater Efficiencies? Evidence from the U.S. Defense Industry
Hensel, Nayantara, Business Economics
The question of whether mergers in various industries lead to greater market power or improved efficiencies has been the subject of numerous public policy debates. This analysis focuses on the impact of consolidation in the U.S. defense industry over the past 20 years and examines the reasons behind the wave of defense consolidation, the results in terms of the reduction in contractors, the antitrust response to mergers, and evidence on the impact of the mergers on weapons systems' total and per-unit costs. The analysis finds that merger activity was driven less by declines in spending following the Cold War than by a stronger economy and a vibrant financial market. The cost data show that 39 to 44 percent of systems experienced statistically significant change in either total costs or per-unit costs following a merger. Somewhat more systems were likely to exhibit lower postmerger per-unit costs than higher per-unit costs, suggesting improved efficiency. The analysis also examines the impact on weapon systems cost by type of weapons system, manufacturer, and service (Army, Navy, Air Force). The evidence suggested greater EFFICIENCIES following consolidation for many sectors. Army and Navy systems overall showed lower per-unit costs, but the Air Force weapons systems showed mixed results.
Business Economics (2010) 45, 187-203.
Keywords: mergers, efficiencies, defense industry, costs, consolidation
The question of whether mergers in various industries lead to higher prices through increased market power or to lower prices and lower costs through greater scale efficiencies, improved management, or a greater knowledge pool has been the subject of numerous studies and public policy debates. The U.S. economy has faced a series of merger waves over the past century that have provided the context for examining the causes and effects of mergers and acquisitions in various industries. This analysis focuses on the causes and consequences of the wave of defense mergers in the United States during the 1990s. The magnitude of the consolidation in the defense sector from this wave was such that by 2001, the top five defense contractors received 34 percent of all prime contract awards, which was the same share that the top 10 defense firms in 1985 had received [Under Secretary of Defense Acquisition ... 2003, p. 5]. Moreover, 51 separate defense firms or units as of 1980 had been folded into the top four defense firms by 2001 [Under Secretary of Defense Acquisition ... 2002, p. 2]. As the number of large defense contractors has declined, key public policy questions have arisen concerning whether the mergers have led to greater efficiencies, lower costs, and improvements in quality, or whether they have led to higher costs, fewer choices, and larger firms with unwieldy organizational structures. These concerns continue because if the defense budget is reduced at some point in the future, defense contractors may be left with excess capacity (although to a lesser degree than following the end of the Cold War) and may consider consolidation as a means of generating efficiencies and improving profitability.
Many studies in other industries have found positive gains from mergers through combining complementary skill sets to generate economies of scope and new products, through combining fixed costs (including rationalization of production facilities to achieve economies of scale and density), or through entering new markets. Studies that have found that mergers generated value include Healy, Palepu, and Ruback , who found improvements in pretax returns for 50 large mergers between 1979 and 1983. Jensen and Ruback  surveyed the empirical evidence and found that "corporate takeovers generate positive gains," but Hall  and others have found evidence that R&D spending and capital spending were not reduced following a merger. Gaughan  argued that "there is little empirical evidence that firms combine to increase their monopoly power" and cited the results of Stillman  and Eckbo . …